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Yes, I know it isn’t much fun. But waiting is sometimes what the market forces you to do.

And it’s about energy.

As a trader/investor you could expend a massive amounts of energy into a market or a group of stocks without much a reward. Your personal energy is a finite resource, especially the older you get, and I husband it every opportunity I get. So when I see the Canadian market as reflected by the S&P/TSX Composite Index, I sit back and relax and try to do minimal activity. Because I know what is coming….

The Canadian equity market, like all global equity markets, takes its cues from the U.S. equity markets. And as I have written the U.S. equity markets are ‘boxed in’ at the top of the zone bookmarked by EBV+3 and EBV+4, as I have blogged about recently here.

If the S&P 500 were to correct back to EBV+3 or 18% lower, I am sure the Canadian market, as well as other global equity markets, would correct also. Conversely, if the S&P 500 had a positive transit of EBV+4, this would propel the Canadian market higher, EBV+3, would be an important target for the S&P/TSX Composite Index…some 37% higher!

S&P/TSX Composite Index

S&P/TSX Composite Index with weekly price bars and EBV Lines.

As a reminder we aggregate all companies in the S&P/TSX Composite Index into one chart on a market capitalized basis (like the S&P/TSX Composite Index itself), so we can see where the market – S&P/TSX Composite – is trading relative to its EBV lines.

For people new to Model Price Theory [MPT] the index value or equity price can move within an EBV zone with no real consequence. However when a transit occurs – index value or equity price crosses one of our parallel lines – an EBV line, either positive or negative this gives Model Price users a signal that fundamentals are improving or deteriorating, respectively.

So the Canadian markets will rally a little above EBV+2 and then fall back to this same EBV Line for support. Yes, we could have a negative transit as well however if the S&P 500 is still ‘boxed in’ – as it has been for months – we will probably rally back up to the aforementioned and same EBV+2.

So you can expend a prodigious amount of energy trying to trade this ‘ go nowhere’ phase in the market but I’m not sure what kind of profits you will be racking up both on the long and short side of the market. Sure there are exceptions, but the individual stock risk a trader may have to take in a sideways market can be high, and yes, I’m talking from personal trading experience.

Conclusion

The whole world is waiting for a signal from the S&P 500 and Canada is no exception. Do valuations go higher or lower? Global interest rates are now in the process backing up – going higher: What does this mean in terms of equity valuation? (Hint: I wouldn’t necessarily assume lower equity valuations.)

Better still, I believe I have made a strong case for ‘taking the summer off.’ My personal energy is precious and I don’t want to waste it in a sideways, choppy market with little to show for my concentration and thought process. When and if the global equity markets make up their minds, I want buckets of energy to grab my share of trading profits. What about you?

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Sorry Hamlet, but the S&P 500 makes your dithering look decisive. So let’s have a look at what is going on with this index filtered through our Model Price math.

S&P 500 Index with weekly price bars and EBV Lines (colored lines).

As a reminder we aggregate all companies in the S&P 500 Index into one chart on a market capitalized basis (like the S&P 500 Index itself), so we can see where the market – S&P 500 – is trading relative to its EBV lines.

As you can observe the US market, as defined by the S&P 500, is now at the top of the zone bookmarked by EBV+3 and EBV+4. If the market rallied to EBV+4 (2169) this would represent a gain of some 3%. If the market corrected back to EBV+3 (1734) investors would be suffering losses of almost 18%.

For people new to Model Price Theory [MPT] the index value or equity price can move within an EBV zone with no real consequence. However when a transit occurs – index value or equity price crosses one of our parallel lines – our EBV line, either positive or negative this gives Model Price users a signal that fundamentals are improving or deteriorating, respectively.

Top of Zone EBV+4

As I noted in my March comments on this very subject and should be read in conjunction with my May comments here, we could be here for quite sometime – just under EBV+4.

Why?

The best explanation I can offer is the market is waiting. “Waiting for what?” you ask. Waiting for a clear signal from something, I have no idea what, for this index to have a positive transit of EBV+4. Or conversely, sending the S&P 500 down to EBV+3 or some 18 percent lower.

Viewed simply and as a snap shot of risk/reward market metrics this hardly seems like a favorable environment for much of a reward with the amount of risk being taken. In other words, your upside is capped to EBV+4 or 3% higher (unless there is a positive transit of the same EBV+4) and the market index has to fall 18 percent to either a buy signal at EBV+3 or a sell signal if a negative transit occurs of the same EBV+3.

However, and as I have said before, we could be here – at the top of the zone – for years. So time in the market can be rewarding, in terms of dividends, and individual stock returns. Plus our EBV Lines, representing compounding growth in book value, is growing positively giving managements room for dividend increases and share repurchases while we wait for some market resolution to occur. Annual market returns, as viewed by the S&P 500 Index, can still be positive by high single digits, which maybe quite favorable compared to other risk asset categories.

Conclusion

There you have it. The U.S. equity market, as defined by the S&P 500 Index, is ‘boxed in’. Not enough good economic news to send the markets higher…. and not enough bad news…. I think you know the rest.

So we wait. As I noted above, the good news, if there is a silver lining is the growth in our EBV Lines, looking forward, representing positive growth in corporate America’s balance sheets giving management motivation for further dividend increases and stock repurchases giving investors a positive expectation of low single digit returns until Hamlet (sorry the S&P 500 Index) makes up its mind on where it wants to go.

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Every time I look at our model price chart of the S&P/TSX Composite Index I see a visual. What is that visual picture you ask?

Well, first let’s look at the model price chart of the aforementioned Canadian index.

S&P/TSX Composite Index with weekly price bars and EBV Lines.

As a reminder we aggregate all companies in the S&P/TSX Composite Index into one chart on a market capitalized basis (like the S&P/TSX Composite Index itself), so we can see where the market – S&P/TSX Composite – is trading relative to its EBV lines.

For people new to Model Price Theory [MPT] the index value or price can move within an EBV zone with no real consequence. However when a transit occurs – index value or equity price crosses one of our parallel lines – an EBV line, either positive or negative this gives Model Price users a signal that fundamentals are improving or deteriorating, respectively.

This is the visual I have in mind…

Hanging in there!

The Canadian market like this poor little kitten is trying to hang in there. Trying to hold on to EBV+2. Yes, this Canadian market index trades a little above and below this EBV line and has yet to make up its mind where it wants to go.

And this stalemate – between the buyers and the sellers – may last for sometime into the future.

The risk is the S&P/TSX Composite Index falls to EBV+1 or over 16 percent from the March 6th close that I have annotated on the above model price chart.

The other question that should be asked: Can the Canadian market have the strength to rally up to EBV+3 or 20,571 (approx. 38% from the March 6th close). Maybe! Though I think the probability would be low but must be considered. As we all know kittens have a habit of defying gravity sometimes. If the most bullish scenario occurs in the U.S. equity markets (see my March blog post on the S&P 500) then the Canadian equity markets would certainly follow the U.S. lead in terms of expanding equity valuations.

So we wait.

The Canadian market is at support with one of our structural EBV lines, and that makes sense, and it’s waiting. So we have to be patient as well.

As I noted in my last blog, we have seen unprecedented central bank activity so far in 2015 resulting in – no surprise – higher asset (equity) values especially in the United States.

Can asset prices go up forever? Or better still can confidence in the men and women who control central bank activities go any higher when everyone in the investment community is already giving them a standing ovation?

Let’s have a look at our Model Price chart to look for clues on how far asset pricing can go.

S&P 500 Index with weekly price bars and EBV Lines (colored lines).

As a reminder we aggregate all companies in the S&P 500 Index into one chart on a market capitalized basis (like the S&P 500 Index itself), so we can see where the market – S&P 500 – is trading relative to its EBV lines.

As you can observe the US market, as defined by the S&P 500, is now at the top of the zone bookmarked by EBV+3 and EBV+4. If the market rallied to EBV+4 (2175) this would represent a gain of some 2.7%. If the market corrected back to EBV+3 (1739) investors would be suffering losses of almost 18%.

For people new to Model Price Theory [MPT] the index value or equity price can move within an EBV zone with no real consequence. However when a transit occurs – index value or equity price crosses one of our parallel lines – our EBV line, either positive or negative this gives Model Price users a signal that fundamentals are improving or deteriorating, respectively.

Top of Zone EBV+4

I believe it’s fair to say we are finally at the top of the zone (EBV+4). Viewing the market this way, call it my first iteration; this is what I believe is the “top” in the U.S. market – valuation wise.

Long time readers of this blog have seen our long-term model price chart on the S&P 500 Index a few times previously but I include it below to illustrate that even if I view EBV+4 as the “top” of the S&P 500 Index in terms of valuation the market can crawl along just underneath our calculated EBV line for a number of years as the market index did from 2003 to 2007.

Long-term Model Price chart of the S&P 500.

S&P 500 Index with monthly price bars and EBV Lines (colored lines).

Sharp-eyed observers will notice that our EBV+4 line (black line between the ‘Red’ line and ‘Yellow’ EBV line) continues on after the last price bar as of March 2, 2015. We project out our estimation of our EBV line by calculating from a bottom up basis or company-by-company basis adding daily pro-rated mean estimates to each company’s net worth less stated dividends and calculate (forecast, if you will) what our EBV values will look like. We do this on a daily basis to incorporate all the latest changes in company fundamentals within each index.

Our calculation of EBV+4, for March of 2016, is 2378. From the March 2, 2015 close (2117) this suggests an implied rate of return of 12% just on the growth of book values (net of dividends, of course) in the S&P 500 Index. Add in a further 2% for dividends and an investor can guesstimate an implied upside for U.S. equities of 14% without any increase in valuation if things go swimmingly.

But one has to ask the most obvious of questions.

Could the S&P 500 have a positive transit of EBV+4?

This is the second iteration an investor has to consider. Again, as sharp-eyed readers can observe back in 1995, the S&P 500 Index was following along the same EBV+4, when it lifted-off and the index ran up to EBV+5 in 1997. As a matter of fact, as you can see from our long-term model price chart, the S&P 500 index almost made it to our calculated EBV+6, calculated back in the day!

The question has to be asked: Was the economic scenarios or environment different in the 1995-2000 period from the 2002-2007 period?

The answer is a resounding yes!

What was the difference?

The U.S. dollar!

Below is a long-term chart of the U.S. Dollar Index (DXY) from Bloomberg.

U.S. Dollar Index (DXY)

I have annotated on this chart the various Bull/Bear market cycles of the U.S. Dollar (DXY Index) coinciding with each U.S. President.

Hopefully, you can clearly see the difference between the two equity bull markets of 1995-2000 and 2002-2007 periods. The first, 1995-2000 equity bull market, occurred while the U.S. dollar was also in a bull period, while the second, 2002-2007 equity bull market occurred while the U.S. Dollar Index was going down or in a bear market.

I have been on record, certainly on BNN and other media outlets, that I believe the fundamentals are in place that we can see a value on the U.S. Dollar Index that would rival the Ronald Reagan Bull Market of the U.S. Dollar Index at over 160. (Maybe this is a little optimistic but certainly Clinton’s Bull Market rally to over 120 would certainly work in my analysis.)

When global money flows pour into the U.S. Dollar, as momentum is starting to pick up since December 2014, global investors will look for U.S. dollar dominated assets to park their cash. Yes, the U.S. Treasury market is an obvious choice but certainly some money flows will seek out the S&P 500 Index ETFs for diversification and maybe a little extra return…. not to mention a 2% dividend yield that rivals current 10-year U.S. Treasury yields.

Is the analysis too simple? Sometimes simple is best!

And yes, fundamentals do count… eventually over secular periods of time, however in my experience money flows usually trump fundamentals over the short-term.

What Am I Saying?

Readers have to consider that conditions are in place that a positive transit of EBV+4 is indeed possible and if money flows get out of hand or momentum is too strong EBV+5 could indeed be possible.

The risk here is that the investment community is way too bearish and conditions are in place that the U.S. equity markets have another EBV zone to go, in terms of valuation, to the upside.

Model Price Theory has the timing problem solved!

You hear and read this all the time on various websites, especially on bearish or perm-a-bear forecasts. Yes, the world is coming to an end because of all these very logical reasons however they can’t tell you ‘When’ this will happen.

O.K. you will face financial ruin…. but we can’t tell you when.

Model Price Theory [MPT] to the rescue!

How does MPT solve the timing issue you ask? Easy, wait for any negative transit of one of our EBV lines. Will this negative transit occur at EBV+4, EBV+5 or EBV+3? I haven’t a clue…but I will know it when I see it.

Doesn’t this solve the timing problem?

I believe so. So on a negative transit, any negative transit – which I will probably blog about – somewhere out there in the future, we will turn cautious on U.S. equities.

Again, my critics may scream “too simplistic.”

I don’t know about you but I do like “simple.”

Conclusion

The S&P 500 Index is now at the top of our EBV zone between EBV+3 and EBV+4. I have speculated or hypothesized on two iterations where the S&P 500 Index either crawls along just under EBV+4 until fundamentals or money flows start to turn negative – that could be years down the road – or the S&P 500 Index has a positive transit of EBV+4 and may have enough momentum to carry the index all the way to EBV+5.

Do I know for certain which scenario will occur? No, I don’t.

But I am certain any negative transit will give me the opportunity to adjust my asset allocation to a more cautious stance if and when this aforementioned negative transit has indeed occurred. And I will be ready for the widely believed financial calamity everyone seems to be forecasting.

P.S. I would be remiss not in acknowledging the anniversary of the bottom on the S&P 500 Index six years ago – on March 9, 2009 to be exact – at an index level of 666.

Not to be overly overt but I have included a screen shot of the front page of our Acker Finley website giving the performance relative to our benchmark (S&P 500 Total Return Index in CDN$) of our Acker Finley US Value 50 Fund priced in CDN dollars. Yes, we are up over 350% from March 3, 2009 to present, after all fund expenses.

Acker Finley Select US Value 50 Fund performance over the last six years. March 3, 2009 – March 4, 2015

I will never forget this bottom for as long as I live and it hardly seems possible that this event occurred six years ago – feels like yesterday.

A substantial part of this return occurred because we were fully invested at the market bottom on March 9, 2009.

For those interested, I blogged what I did differently in the market crash of 2008 that I didn’t do in my previous experienced market crashes of 1987 and 2000 on the fifth anniversary of the market bottom obviously one year ago. Of all my blogs this one remains one of the most popular.

January saw an unprecedented amount of central bank activity. By Zero Hedge’s count a total of 14 independent national central banks, including Canada, eased interest rates in the first month of 2015. So the market focus was not on equities per se but on the global macro view that any experienced market watcher would have to admit is cloudy to say the least.

Central banks are the elephants in the global finance circus and their actions have significant consequences to global fund flows and ultimately asset pricing. So to have the absolute number and the actions of so many of these institutions is unprecedented.

However have a look at our model price chart for the S&P 500 and you see an equity market that is patiently waiting for all the fireworks to die down and a hair’s breath under all time highs set in December.

S&P 500 Index with weekly price bars and EBV Lines (colored lines).

As a reminder we aggregate all companies in the S&P 500 Index into one chart on a market capitalized basis (like the S&P 500 Index itself), so we can see where the market – S&P 500 – is trading relative to its EBV lines.

As you can observe the US market, as defined by the S&P 500, is still in the middle of the zone bookmarked by EBV+3 and EBV+4. If the market rallied to EBV+4 (2196) this would represent a gain of some 6.5%. If the market corrected back to EBV+3 (1756) investors would be suffering losses of almost 15%.

For people new to Model Price Theory [MPT] the index value or price can move within an EBV zone with no real consequence. However when a transit occurs – index value or price crosses one of our parallel lines – an EBV line, either positive or negative this gives Model Price users a signal that fundamentals are improving or deteriorating, respectfully.

So what are my observations for the month of January 2015?

The U.S. equity market is waiting. It’s being patient. Central banks the world over are doing stuff…mainly lower interest rates and quantitative easing…and the U.S. market is waiting for the impact or the result of all these actions.

No big deal….

And as far as answering the question of which board game the central banks are playing? I’m not sure, and willing to bet that central bankers have to improvise and modify what they are doing in different time periods as the economic analysis indicates. My point is that US equity markets seem happy to be patient and don’t really care which game their playing. And if the US equity markets are happy so am I.

Want some proof? I will reblog a blog post I did on March 24, 2014 titled “What if?” quoting extensively from a speech from our recently appointed Bank of Canada Governor, Mr. Stephen S. Poloz.

Mr. Poloz was telling everyone and anyone, almost a year ago that Canada was not going to be the hotbed of growth – far from it – for the foreseeable future. And he made these comments well before the price of crude oil crashed in the last few months of 2014 that will negatively impact both Canadian government budgets and growth prospects (capital spending) for 2015. Mr. Poloz back on March 18th, 2014 took the opportunity to speak plainly to all of us who were willing to listen.

And to add insult to injury, according to Bloomberg, no Canadian economists polled forecasted a downward change in interest rate policy for the Bank of Canada for the first few months of 2015.

So have a read (or reread) of my reblog, especially in the light of today’s news, and I think you will come to the same conclusion as I did…that the next move on interest rates from the Bank of Canada was going to be DOWN (that happened today) and this was telegraphed almost a year ago.

And I will also reiterate, as I did in my “What if?” blog, that the Bank of Canada reduced its bank rate from 1% to 0.75% – obviously by 0.25 basis points – leaving another 0.75 basis points to zero matching all the other major central banks in the world today.

I’m still in mourning over Mark Carney, the former Governor of the Bank of Canada, leaving us for the Bank of England.

So I haven’t focused at all on our new Governor of the Bank of Canada – Mr. Stephen S. Poloz. So on Tuesday, March 18th, 2014, I was heading to our office kitchen, for my one cup of Earl Grey tea I allow myself, through our trading and technology office space when Mr. Poloz was on our trading floor big screen television and said three words that made my head spin around.

“Blah, blah, blah, … lower interest rates, blah, blah”!

Nursing my whiplash, I know one thing about ‘Central Bankers’; they would never say these three words in any context without thinking through its communication value.

So I went to the Bank of Canada website to read his speech, “Redefining the Limits to Growth”, he delivered to the Halifax Chamber of Commerce, in obviously Halifax, Nova Scotia.

Let me say, every Canadian investor should read this speech! For a central banker this speech is direct, forthcoming and has huge implications for your investments – not to mention the future for your kids and grandchildren.

Mr. Poloz is giving everybody a very direct assessment of the Canadian economy and its not very good. Down right scary as a matter of fact.

The highlights include:

1) Five years after the financial crisis the world economy is still stuck in a period of slow growth – say 2% annual growth, if we are lucky.

2) For the first time in 50 years, and starting in 2011, the growth rate of the population of working-age Canadians crossed below that of the overall population. As a way of comparison the US still has 0.2% – 0.3% growth in hours worked – a small but still growing population of working-age people.

Why is this important? Mr. Poloz explains in his speech, “Long-term economic growth is driven by two factors: 1) growth in the supply of labour, which is connected to population growth and changes in its composition, or what we call “demographics;” and 2) productivity growth, which is economists’ shorthand for how efficiently we produce goods and services. For illustration, if we had 2 per cent trend growth in the supply of labour and 1 per cent trend growth in productivity, trend growth for the economy would be about 3 per cent.

So the growth rate of the population of working-age Canadians will be negative for the seeable future, say negative 0.1% – 0.2% annually.

Therefore our only growth influence in the Canadian economy will be the nebulous and hard to pin down productivity growth that economists calculate. Mr. Poloz stated “Productivity growth fluctuates around a long-term trend, tending to be weak during recessions and the early stages of a recovery, and stronger in periods of economic expansion. It follows then that the weakness in productivity growth since the financial crisis may be a symptom of a post-crisis hangover. Indeed, in Canada, the latest data show a pickup in productivity in the second half of 2013, to around 2 per cent, which is very promising.”

Really!

Let’s look south of the Canadian border to look at long-term trends of productivity growth in the US. According to Jeremy Grantham, of the money management firm GMO, for forty years after WW II economists calculated productivity growth of around 1.8% per year. Unfortunately the following thirty-year period saw US productivity growth slowing to 1.3%. With some economists seeing a trend of lower productivity growth in the foreseeable future. This is in the United States, the most productive and inventive society on earth.

Mr. Poloz points to a short-term spike in productivity in the Canadian economy over a certain period of time but no one – at least not me – really believes that Canada will out do the US in terms of productivity growth. And remember productivity growth is really hard to measure, if at all.

So, do the math. The CDN labour force is contracting say, 0.1%-0.2% per year. Productivity growth, let’s just say, it’s the same as the US – big assumption, in that productivity is growing 1.3% per year. So the maximum growth rate in Canada over the foreseeable period of time will be 1% per annum – if we are lucky!

Going one-step further inflation in Canada has been falling like all industrial countries all over the world. Inflation last year in Canada according to Mr. Poloz was 1.2%. The goal of the Bank of Canada is to have 2% annual inflation. So there will be no real growth in Canada for the foreseeable future!

Mr. Poloz states “the global economy may not be just suffering through a hangover from the financial crisis. There are other, longer-term forces at work as well. Some analysts are suggesting we may be facing a long period of secular stagnation. On this alternative view, the economy could perform well below normal, leaving many out of work or underemployed for a long time to come.”

Candid hard-hitting stuff!

3. Mr. Poloz cites the Club of Rome! “Over 40 years ago, the Club of Rome published a book entitled, The Limits to Growth. To the global think tank, those limits were about finite natural resources and the environment. Although the timing remains uncertain, its arguments remain relevant today.”

This, my friends is jaw dropping. For a central banker to cite the Club of Rome, in a public address is unheard of. If Janet Yellen, the new Chairperson of the US Federal Reserve, had made this reference, and maybe she will in the future, the US would be in a full-scale panic with both public and private debates on how the US economy can exceed these “Limits to Growth” and reference the presidential years of one Jimmy Carter.

4. There are other items in his speech that are interesting. Including statistics on where Canadians are allocating an ever-increasing and significant portion of their wealth over the last 10 years. Interested? My lips are sealed in hopes that you will read the speech.

Conclusion

Shocking speech and a must read. Mr. Poloz wasn’t on my radar screen but he is front and center now. The investment implications of this speech are quite real and should be considered by all investors.

So “What if” Mr. Poloz is right?

My interpretations are:

1. The Bank of Canada rate – similar to the Fed Funds rate – is still around 1%, leaving Canadian chartered bank prime at 3%. The US Fed Funds rate is 0 – 0.25%. The Bank of Canada still has room to drop interest rates, if need be. When, not if according to this speech, the Bank of Canada starts to reduce short-term rates look for GIC’s and other short-term debt instruments to follow suit squeezing retirees and savers even further.

2. We have already seen a decline in the value of the Canadian dollar under 90 cents to the US dollar. The weakness is probably making Mr. Poloz happy, in that a weak CDN dollar is giving the Canadian economy, especially Ontario; a must needed boost (cheaper exports) and higher short-term import inflation. The economic impact of the lower CDN dollar does take time. I’m sure the Bank of Canada will be monitoring export growth, import inflation and interest rates very carefully in the future however this speech is confirmation to me we are probably in the early stages of a secular decline in the CDN dollar vis-a-vis the US dollar. (Something I have been professing over a year and a half ago.)

3. Interest sensitive Canadian equities will probably have another bull rally to valuations higher than their previous stated valuation highs – EBV Levels – as income investors scramble for higher dividend and income returns that are lacking elsewhere or when the Bank of Canada starts to reduce the Bank of Canada rate.

4. Canadian companies that have any growth, say high single-digit or low double-digit growth, in any Canadian or international economic market sector will have a high valuation (EBV Level) as investors will pay any price – valuation – for growth in a no-growth country (maybe world).

5. Assuming all the above happens, this will increase the valuation of the S&P/TSX Composite from currents levels to EBV+3. See chart below. This will imply an upside of approximately 35% from current levels.

If the S&P/TSX Composite did achieve this valuation level, EBV+3, in any future time period this would represent full value for this Canadian Index and much needed caution for Canadian equity investors.

On Thursday morning the Swiss National Bank (SNB), Switzerland’s central bank, shocked everyone by eliminating the floor on the Swiss franc and will start charging a negative interest rate (0.75%) to anyone holding their national currency.

In response the Swiss franc exploded upward, up almost 30% against the euro and other global currencies. This move was one of the biggest currency shocks since the collapse of the Bretton Woods system in 1971, as many financial columnists have pointed out.

So let me be clear…. if I had $1 million Swiss francs on deposit at a Swiss bank, the bank is now charging me $7,500 francs per annum for the pleasure of holding these Swiss francs. The result? Individual and global institutions lining up Thursday to purchase Swiss francs!

Huh?

Global finance has gotten a little crazy these days, don’t you think?

The other little thing – tongue in cheek – that is going on is nominal interest rates on any and all government debt has been falling like a stone over the past year. Except for Greek government debt, and who knows whether a bondholder will eventually get paid back in Greek euros or drachmas, all sovereign bonds yields have had a big move in price (upward) and yield (downward). Shouldn’t interest rates be going up by now?

I have to say these bond moves (big moves by historical standards) have become the 800-pound gorilla in the room of all portfolio managers and investment strategists. Nobody, it seems can explain it (lower yields) but better still nobody can say where the yields are going and certainly nobody wants to extrapolate what this means for the global economy.

So what is the end game here, I continually ask myself… in terms of global bond yields?

And let me go further to posit the question: Will nominal yields on all sovereigns go to zero? (Germany, Japan and a few other European countries have negative interest rates on their government bonds – up to 5 year and less – why not Canada?)

Here is screen shot of one of my favorite screens from the Bloomberg website showing 10-year yields of the major countries in the world and how much the yields have fallen during the year.

Screen Shot of Bloomberg Website Page

As Paul Krugman writes in his column, “Francs, Fear and Folly,” in the New York Times, “What you need to understand is that all the usual rules of economic policy changed when financial crisis struck in 2008; we entered a looking-glass world, and we still haven’t emerged.”

Can Model Price Theory explain what is going on here?

Partially.

First I want to show you two charts. The first graph I tweeted out back in November 2014 showing the global total debt (excluding the financial sector) for advanced economies plus major emerging market economies. As you can see debt has been growing at healthy rate over the last 12 years. Of course most of this increased debt is national and territorial governments issuing large amounts of debt to supplement increased economic activity.

Global debt to GDP

The second chart is our Solvency Curve that I introduced to you back at the start of this blog and one of our ‘Key Concepts’.

Solvency Curve from Model Price Theory – See Key Concepts

It’s the dynamic of what the economic actors are doing along our ‘Solvency Curve’ in each national country over a period of time is what I’m pointing out here. First, each national government, since the financial crisis of 2008, has substantially increased their national debt – some larger than others. This Keynesian national debt increase helped individual and together globally national economies sustain and increase economic growth to correct substantial drops in global demand that occurred around the world because of the financial crisis of 2008.

As government debt increased, all national governments moved down our ‘Solvency Curve’ – left side – to a more insolvent state. All the other economic actors in each society see this, individuals and corporations, etc., and increase their own solvency to brace for future of tax increases (to repay the national debt accumulated) and reduced capital investment plans or projects to conserve cash as future growth looks uncertain.

For example, in Japan where the government has tried to lift the country out of its economic malaise and deflation, after its own financial crisis, for over the last 25 years has spent enormous amounts annually (budget deficits) to increase nominal demand and has increased the national debt to a staggering 229% of GDP – the largest of any country in the world today. Unbelievably, as the national government debt has risen, total cash held by individuals and corporations have also grown to a staggering 44% of GDP. Hope you see the dynamic going on here. The national governments going one-way (down our ‘Solvency Curve’ and everybody else is shifting (becoming Super-Solvent) to the right of our curve in response.

I know and would like to emphasize our concept – Solvency Curve – and movement along our ‘Curve’ is not the cause (not fully) of our current interest conundrum. It’s just until world governments and their respective central banks slow down this cycle or movement along the curve – each side of the curve moving away from each other – that lack of global growth and dis-inflation bordering on deflation is going to continue to occur.

Resulting in ever lower interest rates.

When and if these ‘Solvency Curve’ trends start to slow down or better still reverse (having national governments become more solvent allowing individuals and corporations to spend their cash and move up the right-hand side of the ‘curve’) do interest rates have the slightest chance of moving upwards.

Or is something going on here that is more prophetic with regards to interest rates.

Sometimes when I view this Bloomberg 10-year government webpage I feel it’s more like a countdown. I’m I witnessing a secular fall in interest rates that will last for a generation? Will global long-term interest rates in the western world and Europe go to Japanese levels and perhaps stay there, again, for a generation? What happens to western society, business investment and retirement plans if and when we have low interest rates for a prolonged period of time? Do these questions make any sense? Am I scarring you?

How are we in the west, the developed nations, supposed to retire if interest rates go to zero? Want to earn $100,000 in interest income? Well, at the current interest rate of 1.53%, a Canadian resident currently needs $6.5 million invested in a 10-year Government of Canada bond. Who has this amount of loose change lying around to retire on? But, I guess, the good news is that interest rates are 1.5%! What happens if they go to zero?